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Potential for Double-Dip Recession Seems Small

By Hale Stewart September 6, 2010 12:13 pmSeptember 6, 2010 12:13 pm

Over the last few months there has been an increase in the concern and discussion over a possible double-dip recession, particularly after unemployment reports over the summer showed that the nation was shedding tens of thousands of jobs. However, a key element lacking in the talk of double-dip recessions is what actually caused past recessions – that is, what are the primary reasons an economy slows to the point where its growth contracts for at least two quarters – followed by an analysis of whether those conditions exist in the current economic environment. And judging from a variety of indicators, the potential for a double-dip recession seem small.

Perhaps the most obvious economic indicator of a coming recession is rising interest rates, one of the primary policy tools available to the Federal Reserve. According to generally accepted wisdom, the Fed is supposed to lower interest rates during a recession to spur lending and loan demand, and then raise interest rates after the economy expands to prevent inflation from getting out of hand. Here is a chart from the St. Louis Federal Reserve’s FRED system, which shows the weekly effective federal funds rate:

Notice that the line typically increases before the gray shaded areas that represent recessions, demonstrating that short-term interest rates rise before a recession. Also of importance is that before the last true double-dip recession in the early 1980s, short-term interest rates were incredibly high – a policy move championed and implemented by the Fed chairman at the time, Paul Volcker, to kill inflation. Finally, the chart shows that short-term interest rates are the lowest they’ve been in over 50 years, an event that typically occurs as the economy is exiting a recession, not entering one.

Another leading cause of recession is some type of financial crisis that paralyzes a significant portion of the financial intermediary system. This is what happened in the Great Depression, especially during the years 1929-33, when in fact there were three banking crises: the first in late 1930, the second in early 1931 and the final in mid-1932. The savings and loan crisis of the late 1980s was a contributing factor to the early 1990s recession. And the bursting of the housing bubble in 2007-08 led to a broad financial meltdown that prompted the latest recession.

However, according to the F.D.I.C.’s latest Quarterly Banking Profile, the banking industry is starting to heal. Earnings are up, and charge-offs fell for the first time since 2006. This is not to say this part of the economy does not face issues; there are still over 800 “problem” institutions that have a little over $400 billion in assets. However, the underlying trends indicate that this sector of the economy is mending rather than getting worse.

Commodity price increases – especially in the oil market – are also leading causes of recessions. James Hamilton, an economics professor at the University of California at San Diego who writes at Econbrowser, has done some of the most in-depth research on this topic. He has noted that 10 of 11 recessions are preceded by an increase of some sort in oil prices. As he noted in a paper, Nonlinearities and the Macroeconomic Effect of Oil Prices, Iraq’s invasion of Kuwait led to a quick doubling of the price of oil in 1990. Oil also doubled in price during the 1990s and doubled again in 2007-08 before the latest recession. The reason for oil’s effect on the economy is simple: oil is a commodity that the United States must use in large quantities for a variety of necessary economic functions. In addition, oil prices above certain levels have an important psychological impact on consumers, and can affect consumer sentiment and spending when certain levels are reached. Currently oil prices are trading at roughly $70 to $84 a barrel, and gasoline has been around $2.80 a gallon for the last six months. In short, oil prices and commodity prices in general are not at levels to cause a recession.

A final cause of recessions is a bursting of some financial bubble – a leading cause of the last two recessions. In the 1990s, the S&P 500 increased from a little below 400 at the beginning of the decade to over 1,400 at the end of the decade – a massive increase not seen before. During the latest expansion, home prices as measured by the Case-Shiller Price Index increased from a reading near 100 in the year 2000 to over 180 in 2006 – a near doubling in prices in less than a decade. A bursting bubble usually leads to depressed consumer sentiment, and therefore lower consumer spending. In addition, lower housing and stock prices reduce the value of consumers’ balance sheets, making them feel less affluent – and less eager to spend. Now, while the nation continues to feel the blunt aftermath of the bursting of the housing bubble, there does not appear to be other segments of the economy that have the same overheated quality that housing had a few years ago.

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This is an archive of posts from FiveThirtyEight, a blog founded by Nate Silver in 2008 and devoted to rigorous, data-driven analysis of politics, polling, public affairs, sports, economics, science and culture, from August 2010 through July 2013.